Being in debt is a terrible feeling. It controls how you live your life, in many ways. Most people who are buried in it will say they would do just about anything to eliminate debt.
I was one of those people who said that all the time, but I still never did anything to get rid of my debt. To be totally honest with myself, I don’t think I even believed that it was possible for me to ever be out of debt.
I know NOW that it is very possible to eliminate your debt.
- It takes some serious commitment.
- It takes a major lifestyle change.
- It requires an adjustment to the way you spend.
- It usually requires that you sell possessions in order to eliminate debt.
Recently someone asked me if it would be wise to sell their shares in a stock that had been given to them many years ago and use the proceeds to pay off debt. I’m not an investment advisor, but I did my best to offer him a few things to think about. In fact, If you are thinking about selling stocks, or other investments to pay off your debt, there are a lot of things you should consider before making that move.
Why are You in Debt in the First Place?
What are the underlying reasons that you have debt? Have you been working on paying off your debt, or is it still increasing? How great are the chances that if you pay off a credit card, that you won’t turn around and charge it up again?
In other words, you have to first be sure that your habits that caused you to be in debt in the first place have been changed. Stop spending money that you don’t have. Quit using credit cards. Tighten the purse strings and make sure that you are living on a budget where your expenses are less than your income. Put together a plan for paying off the debt – a debt snowball, or debt avalanche.
If you haven’t taken care of the underlying habits that originally got you into debt, the chances are strong that you will get right back into debt soon after paying it off. Then you will have the debt and there will be no investment left to do anything with later.
If you are on a plan and aggressively working to get the debt paid, then let’s consider using the investment as a way to get the debt lowered more quickly. First, read the rest of this article.
Leave Your Tax Advantaged Investments Alone
The question that I’m addressing is in regard to an individual stock in a brokerage account, so this point doesn’t pertain to the question. I still fell that the topic selling or borrowing against tax advantaged accounts is an important one.
Whenever I hear of someone cashing out 401k funds and paying the taxes and penalties for the early withdrawal, it makes me want to cry. Don’t do that. In fact, I highly recommend that you not even borrow against your 401k. Doing so eliminates the potential for gains on that portion of your investment. I’ve been there. I’ve done that. I’m not proud of it. I wish I could have a do-over. I’m still paying my 401k a 4 1/2% rate on money I borrowed from it while the remainder of the investments are earning somewhere around 20% right now. Ouch!
Expected Return on the Stock vs the Interest Rate on Your Debt
What are you expecting your stock investment to do? What have your returns been? What dividends are being paid? Do you expect that trend to continue?
The stock in question is a mature financial services company whose price has bounced around without making any significant advances for many years. The price tanked by about 75% during the 2008-9 crash and took until 2016 to recover to the pre-crash prices.
Finally, over the past two years, the price has increased by more than 20% each year and is at an all time high. The price gains seem to correspond with the company making significant investments to become more “digital”.
Given the way the stock market, as a whole, has been climbing and reaching all time high prices, many people are speculating that we are due for a significant correction. I have similar concerns, but I’m not in a panic. I’m not about to get out of the equity funds in my portfolio.
Since I’m not an expert, my opinion on the subject should carry little weight. I just throw this all out there as something to consider while you do some research for yourself, or consult a qualified expert.
Even if you aren’t going to use the proceeds to pay off debt, it might be worth looking into selling the stock and using the proceeds to purchase something more diversified. A mutual fund or ETF that tracks an index might be less susceptible to a significant market correction. I’m not suggestion you do that – it’s just another consideration.
The other side of this is the interest rate on the debt that you’ll be paying down. Look at the rate you’re paying and do the math. Paying off debt is like investing your money at a guaranteed interest rate. If the interest rate on your debt is more than about 10%, I would give strong consideration to the idea of selling your investment to pay off debt.
Most investments won’t return you more than 10% over time. The 10 year return on the S&P 500 is just less than 10%. That’s an index that most people consider as an indicator of what the market is doing. If your investments consistently average higher than the S&P 500 over time, you’re doing pretty well. Paying off a 16% credit card would be considered very good.
Tax Implications of Selling Stock
Don’t forget that you have to pay capital gains if you sell your stock. Once you sell the stock, you realize the income and you have to pay Uncle Sam for the privilege. In 2018, long term capital gains are 0%, 15%, or 20%, depending on the tax bracket you are in. Depending on the state you are in, there are possible some state taxes, as well.
Just make sure you know the penalties of selling, so that you can figure that in to your decision and to hold enough money back to pay the taxes when they become due. Failing to do that might cause you to go right back into debt, after all is said and done.